Pricing on Purpose: How to Implement Value Pricing in Your Firm

A
business is defined by the value it creates for its customers. Your
price speaks volumes about your value proposition, more so than any
other component of your firm’s marketing. The business world pricing
revolution began in the 1980s, when many of the Fortune 500
companies began to employ professional pricers, and organizations
such as the Professional Pricing Society were founded to assist
companies in achieving excellence in pricing for value. Yet many CPA
firms are still defined by “hourly rates.” The CPA profession has
taken its collective intelligence, experience, judgment, education,
wisdom, knowledge, and intellectual capital and commoditized them
into a one-dimensional hourly rate. This article illustrates that
pricing by the hour is the wrong way to measure the value created
for the client.

THEORIES OF VALUE

Professionals
undervalue their services because they are operating under the
labor theory of value, which posits that the value of a
service is determined by the amount of labor used in its production.
Conversely, professionals who subscribe to the subjective theory
of value believe that the services they offer are only
valuable to the extent that there is a potential buyer desiring
them. Value is in the eye of the beholder. For any transaction to
take place, both the buyer and the seller must profit from the
exchange and receive more value—in their subjective perception—than
what they are giving up.

Today,
thousands of firms price their services according to the external
value created—as perceived and determined by the client—rather than
internal costs incurred in generating those services. (For a summary
of the advantages of value pricing, see Exhibit 1, below.) Changing
the pricing culture in your firm will not be easy. It requires
confronting the inherent challenges involved with pricing—all of
which take hard work, commitment, leadership, creativity,
innovation, and dedication of resources to continuing education.

Exhibit 1: Advantages of Value Pricing

Value
pricing comports with the laws of economics and consumer
psychology, aligning the interests of the firm with those of
the client.

It
manages, clarifies and offers the firm the ability to exceed
the client’s expectations.

It
prequalifies the client to ensure they are a good fit for
the firm.

It
provides the opportunity to cross-sell additional
services.

It
allows you to gain “ego investment” from the
client.

It
improves communication.

It
projects confidence and experience, as opposed to being
unable to inform the client upfront of a price as with
hourly billing; or offering a range of prices, which is done
more for the benefit of the firm than the
client.

It
increases a client’s switching costs, increasing their
loyalty and long-term profitability.

It
forces the firm to be effective in project management and to
get the work done within the time promised to the
client.

It
overcomes the client’s pricing emotions and maximizes the
firm’s price leverage.

It
incentivizes the client to complain—through triggering the
service guarantee—giving the firm a second chance to win
back the client, and prevents similar problems from
happening with other clients in the future.

Fixed-price
agreement (FPA) prices can be increased each year, even if
there are no changes in services. It is much easier to
increase the price of a customized FPA rather than
increasing your hourly rate by $10 per hour.

It
provides a competitive differentiation for your firm when
you offer clients certainty in price and less risk of
dealing with you.

It
specifies conditions for change orders that are usually
value-added services that can command a premium
price.

It
uses price bundling, allowing the client to focus on the
totality of the firm’s value proposition rather than the
price of each service.

VALUE PRICING VS. VALUE BILLING

Value is
defined in economic terms as: The maximum amount that a consumer
would be willing to pay for an item. Therefore, value
pricing can be defined as the maximum amount a given client
is willing to pay for a particular service, before the work
begins. This is not to suggest we can capture 100% of maximum
value, but rather that we have the potential to access some of it
with strategic pricing. (Also see "Price Psychology".)

This
definition contradicts the popular term value billing. The
difference is value pricing is always done before the work
begins, whereas value billing is usually marking up—or more
frequently, marking down—the invoice to the client after the
work has been performed.

A
cardinal rule on behalf of clients in firms that value price is: no
surprises. Just as no auto mechanic performs work not pre-authorized
by the customer, these firms only provide services after price,
payment terms and scope have been predetermined and agreed to by the
client. This creates a better client experience, with fewer
write-downs and write-offs, lower collection and financing costs,
and greater client loyalty—not to mention superior profitability for
the firm.

TRANSITIONING FROM HOURLY BILLING TO VALUE PRICING

Not
all pricers in a CPA firm are created equal. Firms should establish
a pricing council and appoint a chief value officer (CVO) in order
to centralize the pricing function and make it a core competency
within the organization. Pricing is too important to the
profitability and health of a firm to accept anything less than
excellence in this vitally important skill.

If
you diagram hourly billing, a form of cost-plus pricing, it would
look like this:

Service
Cost
Price
Value
Client

Value
pricing inverts the above chain by recognizing the economic fact
that the client is the ultimate arbiter of value:

Client
Value
Price
Cost
Service

Thus,
value pricing turns the order of cost-plus pricing inside out. Goods
and services do not magically become more valuable as they move
through the factory and have costs allocated to them by cost
accountants. Firms that value price do not ask, “What prices do we
need to cover our costs and earn a profit?” Rather, they ask, “What
costs can we afford to incur on this project given the price
obtainable from the client and still earn an adequate profit?” Costs
in a CPA firm are largely fixed, but pricing is a policy. In most
CPA firms, services are priced based on the costs incurred and not
the value created. These firms have ample data on their
costs, hours, activities, efforts and other inputs, but a paucity of
information on the value they create for clients.

In
firms that use value pricing, costs only determine if a service
should be provided, and in what quantities. Costs do not play a
role in determining external value to the customer, or setting
prices (except as a minimum).Value pricing reverses what is now an
artificial ceiling on firm income, inverting the ceiling into a
floor.

THE EIGHT STEPS REQUIRED FOR PRICING ON PURPOSE

Follow
these eight steps on every major engagement, and your firm will be
on its way to pricing on purpose:

STEP 1

Have a
conversation with your client to determine their needs and wants
in the forthcoming year. Ask them the questions in Exhibit 2
(below). This is your opportunity to comprehend and
communicate the value you can add, establishing the scope
of value and then the scope of the work to be performed. Sometimes
a member from the pricing council attends this meeting, especially
if the partner is not a member of the pricing council, or is
uncomfortable with pricing.

Exhibit 2: Questions to Ask the Client

What
do you expect from us, and how do you see us helping you
address challenges and opportunities?

What
growth plans do you have?

If
price were not an issue, what role would you want us to
play in your business?

Do
you expect capital needs? New financing?

Do
you anticipate any mergers, purchases, divestitures,
recapitalizations or reorganizations in the near
future?

We
know you are investing in total quality service, as are
we. What are the service standards you would like us to
provide?

How
important is our service guarantee to you?

How
important is rapid response on accounting and tax
questions? What do you consider rapid
response?

Why
are you changing firms? What did you enjoy about your
former firm? What did you not like about your former firm
that you do not want us to repeat?

Are
you concerned about any of your asset, liability or income
statement accounts to which we should pay particularly
close attention?

How
do you suggest we best learn about your business so we can
relate your operations to the financial information and so
we can be more proactive in helping you maximize your
business success?

What
is your budget for this type of service?

STEP 2

The
information gleaned from Step 1 is then presented to the
pricing council, where three options, at three levels of
service, are established. For example, American Express’
Green, Gold and Platinum cards vary in price based upon the
value and services they deliver. Firms should offer clients
options, not a take-it-or-leave-it single price. This allows
the client to convince himself or herself of value. It also
reveals the client’s individual price sensitivity, which the
firm can use in future pricing. It helps the firm answer the
question: Did we leave money on the table? If there isn’t
trepidation about the price, then the prices may be too
low.

STEP 3

The
pricing council then goes through the 20 questions to ask
before establishing a price (see Exhibit 3 below). Based upon
the answers, the council then conjectures three internal
prices for each level of service, based upon their assessment
of the client’s subjective value and price sensitivity. In
tough economic times, this three-tier pricing model is a great
opportunity for firms to offer less expensive options for
struggling clients. When times get better, many clients will
often choose to upgrade their services.

Reservation price. Below this price, the firm
would turn down the work. It must get this price.
It will generate a normal profit.

Hope for price. A firm should get this
price more often than not. It will generate a supernormal
profit.

Pump fist price. This is an aspiration
price, when the firm is adding extraordinary value. It
will generate a windfall profit.

Many
firms use the following nine-box model:

Reservation

Hope For

Pump Fist

Platinum

$C

$B

$A

Gold

$N

$M

$L

Green

$Z

$Y

$X

From
this brainstorming session, the pricing council then
determines at which price the three options will be
presented (obviously, not all nine prices are presented to
the client). The upper bound of these prices should be
based upon the value being created, yet all will be lower
than that value to ensure the client earns more value than
the price they paid.

For
example, if you know the client is highly price sensitive,
you may only present the reservation price for all three
options. However, if there are some services that are
adding marginal
value, a hope for price may be quoted for the Gold and
Platinum levels. If extraordinary value is being
created, quote the pump fist price.

This
is where the art of pricing comes into play. It requires
judgment, but the more the pricing council does it, the
better the members will get, since pricing is also a
skill.

Firms
that use this model report that it makes a firm “compete
with itself.” To receive a pump fist price, the firm must
conjure up ways to add extraordinary value. This is a
worthwhile thought experiment that focuses on value, not
time.

Many
people ask how to ascertain value since it’s subjective
and there’s no formula. The answer is with a deep
understanding of your client’s value drivers, which
requires a deep conversation with the
client.

Exhibit 3: 20 Questions the Pricing Council Should Ask
Itself Before Establishing a Price

What
is the client’s cost of not solving this problem
in dollars?

What
is the economic benefit to the client if they
solve the problem?

With
whom on the organizational chart are we
dealing?

Who
referred this customer to us? Why were we referred
in the first place?

Do
they have any time-sensitive deadlines for the
completion of this project? Why do they need to do
it now and not in six months?

Who’s
paying for the service? Are they spending other
people’s money?

Do
we have any competitors? If so, who?

What
price information do we have about these
competitors?

How
profitable is the client’s company? How long have
they been in business?

Have
they engaged with someone else prior to us to do
similar work? Who was the prior firm, and why are
they changing?

How
sophisticated is the client?

Does
the client add to the firm’s skills or
markets?

Do
we like this client?

How
do we help reduce the client’s risk?

At
what price would this be so expensive the client
would not consider buying it?

At
what price would this be expensive, but the client
would most likely still buy it?

At
what price does this become
inexpensive?

At
what price does this become so inexpensive the
client would question its value?

What
price would be the most acceptable price to
pay?

What
costs can we afford to invest in at the target
price and still earn an acceptable profit? At what
price would we walk away? What price do we
desire?

STEP 4

Present
the options to the client. A member of the pricing
council should attend this presentation, especially
if the partner in charge
is not a member of the pricing council or is
uncomfortable discussing price.

STEP 5

The
option selected by the client is then codified into
a fixed-price agreement (FPA). The firm can include
as much detail as required as to the scope of work,
client responsibility to provide information,
timelines for delivery of work, etc.

STEP 6

The
firm would perform adequate project management on
the scope of work, detailing who will perform the
work, timelines for delivery to the client, and
other planning details.

STEP 7

If
the firm finds scope creep while performing
the work, the client is informed, given the option
of how to proceed, and a change order will be issued
if the firm is to perform any additional work. This
policy also applies to any new services the firm
provides within the year not specified in the
FPA.

STEP 8

The
U.S. Army has a policy of performing After Action
Reviews (AAR), which take place after every
mission. After assisting many firms in implementing
AARs, we are convinced it is a practice that would
have numerous benefits for firms, especially as it
relates to the roles of the CVO and pricing council,
helping them evolve pricing into a core
competency.

CONCLUSION

There
is nobility in earning what you are worth. Yet if a
firm’s leaders do not think it creates more value
for its clients than is reflected by hourly billing,
clients may never understand a value proposition
beyond hourly rates.

Hourly
billing is a risk-averse and simplistic tradition
that has been taught for multiple generations. Your
firm will be unable to adopt value pricing if it
continues to denominate everything in hours, thus
remaining mired in the mentality that you sell
time.

Now
is the time to change your conversations with
clients from hours to value.

Do
this upfront, before you begin any work. Appoint a
CVO and establish a pricing council—a group of
intellectually curious leaders who will become, over
time, experts in creating and capturing
value.

Your
firm will become obsessed with value. Your clients
will appreciate it, and they will not bother asking
about hours. I guarantee it. Make your firm one of
the pioneers that is blazing the trail for others by
burying the billable hour and pricing on
purpose.

Change
the pricing culture in your firm from
one that “sells time” to a value pricing firm that
prices services according to the external value
created for the client rather than the internal
costs incurred to generate the
services.

Value pricing means the maximum amount a
given client is willing to pay for a particular
service before the CPA begins the
work.

Value pricing creates a better overall client
experience because
it improves communication between the firm and the
client, offers certainty in pricing, and creates a
service guarantee that allows the firm the chance
to win back the client in the event of a
problem.

To transition from hourly billing to value
pricing establish
a pricing council in your firm to centralize the
pricing function and make it a core competency
within the organization.

Ronald
J. Baker is
the founder of VeraSage Institute. His e-mail
address is ron@verasage.com.

For
more information or to place an order, go to
www.cpa2biz.comor call the Institute at
888-777-7077.

Private
Companies Practice Section

The
Private Companies Practice Section (PCPS) is a
voluntary firm membership section for CPAs
that provides member firms with targeted
practice management tools and resources, as
well as a strong, collective voice within the
CPA profession. Visit the PCPS Firm Practice
Center at www.aicpa.org/PCPS.
The PCPS Pricing Your Services page has
related archived Web forums, articles and
publications at pcps.aicpa.org/Resources/Fee+Pressure+Pricing.

OTHER RESOURCES

The
Strategy and Tactics of Pricing: A
Guide to Growing More Profitably,
4th edition, Thomas T. Nagle and John E.
Hogan, Prentice-Hall,
2006